RUTH SUNDERLAND: Pension funds’ gilty secret

There is an old joke that people become actuaries, devoting their careers to calculating pension risks, because they find the idea of accountancy too exciting. 

After the past couple of weeks of high drama in the torpid world of final salary pension schemes, most people would prefer the normal state of tedium. 

The letter sent by the Bank of England deputy governor Sir Jon Cunliffe explaining how he and his colleagues saved the financial system reads like the script of a slightly nerdy disaster movie. 

The first misgivings were heard over leveraged Liability Driven Investments or LDIs immediately after the Budget. On the Sunday evening, instead of Antiques Roadshow and Countryfile, Bank staff were hunched over their screens, stomachs churning as sterling fell on Asian markets. 

LDI managers warned they would possibly have to sell up to £50billion of gilts into an illiquid market. By the Tuesday, some LDI funds said they would have to start winding up the next day, which would have presented a big risk to the financial system. Bank staff stayed up all night to produce a lifeboat, which has averted a collapse. 

It is a temporary fix, due to end this week, and while it is inconceivable that it would not be extended if another doom loop were to emerge, questions remain. 

There are uncomfortable echoes of the global crisis a dozen years ago, when trouble blowing up in obscure corners of the financial world heralded a wider disaster. The woes of Credit Suisse, which has bought back three billion francs worth of its own debt to shore up confidence, have added to the foreboding. Complacent, light-touch regulation epitomised the financial crisis.

Banks are in general now far better capitalised, but risk has migrated to other parts of the system including pensions and open-ended investment funds. 

The LDI debacle raises some very serious questions for the pension watchdogs. The Bank of England has tried to wriggle out of blame by saying it does not regulate pensions or LDIs, which are mostly overseas. That is no reason to ignore them as the Bank seems to imply; indeed the opposite. 

The Old Lady is responsible for the stability of the financial system overall, and therefore should have noticed the enormous build-up of risk from offshore LDI funds across final salary schemes. 

The Budget was the trigger, but attempts to blame it all on the Government should be treated with scepticism. Pension funds addicted to LDIs were susceptible to a major gilt yield shock from any cause. 

Yet the Bank seemed oblivious and indeed its own staff pension filled its boots. 

The Pensions Regulator looks like a weak and captured watchdog, with senior staff who have been heavily involved in LDI. 

It was heavily criticised for its feebleness over the pension fund at Carillion, whose 27,000 members were left with a £2.6billion net liability when the firm went under in 2018. 

The Regulator promised that lessons would be learned and its powers in regard to reckless employers have been strengthened. The UK is no stranger to pension scandals, from Robert Maxwell to Equitable Life. But LDIs dwarf the lot combined and the Regulator is out of its depth. 

This will lead to even more sponsor companies seeking to offload their final salary funds to insurance companies. 

It should also prompt a re-think of the pensions regime which has thrown up perverse incentives to hold large amounts in gilts: rather than reduce risk as was the intention, it has increased the perils.